What happened overnight
– Surprisingly calm risk-off trading with modest FX price action
FX markets traded in a surprisingly orderly fashion overnight, somewhat insulated from the extended plunge in equity prices. European stock markets are trading 1.9-4.0% weaker, following the 1.3-6.2% losses reported by Asian equity markets.
FX markets have traded these equities moves essentially flat. The dollar is only a touch stronger against the G10 currencies with EURUSD at 1.4306, AUDUSD at 1.0370. USDJPY was much more volatile, rallying to a high of 76.95 on private sector flow, but quickly gave up these gains once this flow finished. Japan’s finance minister continued to warn about intervention and asserted that further yen strength would elicit measures in the new supplementary budget, without giving details. However, the government has yet to actually intervene again.
The Swiss franc is trading slightly stronger against the USD, followed by the JPY and the SGD. EURCHF fell to 1.128 in European hours, after holding at unchanged levels in Asia. The SNB auctioned CHF liquidity again via swaps, with no strong reaction in the forward points. Asian currencies drifted rather than continuing to sell off as in past periods of stress. Again, order flow has been very light, but still generally buying back of USD-Asia shorts
The relative lack of price action in FX markets is difficult to explain with certainty, but we think it stems from a lack of positions. In FX specifically, the choppiness of markets for the past three months has limited positions largely to highly leveraged OTM options rather than large cash positions. Data on net foreign buying in Asian equity markets show very low net inflows year-to-date.
The key question we see, and a key risk for the market, is just how much expectation of an announcement of QE3 at Jackson Hole is priced in the market. We assume the market has to be pricing at least some possibility of this, perhaps 20-30%, even if yesterday’s US inflation data have reduced this possibility and contributed to the equity sell-off. The rising risk we see is that Fed Chairman Bernanke is not in a position to announce anything of substance at Jackson Hole. Our bias is to think this would be a risk negative, slightly USD positive development. If Bernanke does not give markets new ease, the next major policy event will be the ECB press conference in September.
GBP: Public finances improve. UK public sector net borrowing (ex interventions) was ?0.0bn in July, an improvement on the ?3.5bn reported in the same month last year and better than the consensus for ?2.4bn. We note that lower spending rather than higher revenues was behind the result. Receipt growth was stable at 5%yoy while spending growth fell to 1.9%yoy from 5.3%yoy in June. Lower government spending may however add further challenges to the rather weak economy and labour market. Nevertheless, in the current environment the better fiscal situation is marginally positive for the pound, in our view, in luring diversification flows from reserve managers.
NZD: Strong retail indicators in July, but weak net migration. Credit card spending rose 1.0% mom in July, double the 0.5% mom rise in June. This pushed year-on-year growth to 7.3%, the strongest since April 2008. However, net migration remained negative as the outflow of New Zealanders to Australia remained high. This tightens the labour market to some extent, but also threatens to weaken domestic demand. We expect the labour market effect to dominate when Christchurch reconstruction accelerates later this year and next year.
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Credit Suisse
FIXED INCOME RESEARCH & ANALYTICS